Environmental, social and governance (ESG) have become important considerations in mainstream investment processes. Adoption rates vary by region and by sector. Following an extended bull market, the spread of the corona virus in early 2020 and the associated containment measures by various governments caused severe equity market correction starting mid-February. Soon thereafter, crude oil prices collapsed as a price war between major global producers began. As volatility spiked, certain credit markets dislocated around liquidity concerns.
While the crisis period is short-lived so far, the market reaction is dramatic. For many investors, this is probably the first live experience investing in ESG strategies during a crisis period. Some investors may still hold concerns that application of ESG criteria is at odds with the maximization of returns. It is interesting to review how securities that exhibit attractive ESG features have held up compared to securities with poor ESG scores.
ESG performance in the current environment
To investigate ESG performance we constructed portfolios based on a standard aggregate ESG scores, its components E, S, and G as well as some commonly used single indicators, namely carbon intensity (scope 1 and scope 2), human capital management, corporate governance, and tax transparency.1 We built quintile portfolios and computed quintile spread returns for portfolios that are long in the top 20% and short in the bottom 20% companies within a given category. Within this volatile market environment, the spread return analysis shows that the ESG portfolio as well as the underlying component portfolios delivered a positive return. (see figure 1)